Euro Swan Dives; Eichengreen Nails It

The Euro is down big again on debt fears/confusion/politics. Europe needs a plan and we point to Barry Eichengreen's (our bet for next year' Nobel Prize) article posted on Project Syndicate this morning.

There is a fear in Europe and that a bond "haircut" equates to a mark-to-market for all banks holding bonds of the periphery. Some Greek bonds are already trading at 50% of face value and we seriously doubt these have been marked down. Eichengreen writes,

…regulation could be used to reconcile Greece's need to restructure now with the banks' wish to wait until their balance sheets are stronger. Under the Brady Plan, an accounting rule called FASB 15 allowed restructured loans to continue to be booked at their original face value, so long as the sum of interest and principal payments on the restructured instrument at least equaled that on the original credit. New bonds, on which interest was back-loaded, could be given the same accounting value as old ones on which interest was paid earlier.

This special accounting treatment could then be phased out over time, requiring banks to acknowledge their losses, but only once they were able to do so.

There you have it. Europe is in a destabilizing feedback loop that it cannot control. Sovereign credit is deteriorating and this is reducing confidence in national banking systems, causing or increasing the likelihood that sovereigns will have to assume bank liabilities. This further impairs the sovereign credit and increases the lack of confidence in the banks. They need to come up with a plan, and fast! (click here if chart is not observable)